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This review of the fiscal powers of the Northern Ireland Assembly, was commissioned by the Centre for Economic Empowerment and was carried out by PwC.

Executive Summary

The success of previous attempts to agree and implement a vision for the Northern Ireland economy has been limited.

A number of studies, including the Strategy 2010 in 1999, the most recent Programme for Government and the Northern Ireland Economic Strategy have all identified and articulated a vision of a more prosperous Northern Ireland. This is summarised in Strategy 2010 as, “A fast growing, competitive, innovative, knowledge-based economy where there are potential opportunities and a population equipped to grasp them.” Of course, without a single, cohesive and generally agreed economic objective, policy making and objective setting will remain challenging. Hitherto, successful implementation has remained elusive.

There has been little progress towards closing the prosperity gap between Northern Ireland and the rest of the UK.

At least, 15 major reports on the state of the Northern Ireland economy, since the 1957 Isles and Cuthbert’s report have reached broadly similar conclusions about the region’s shortcomings. Successive strategies and reviews have collectively failed to close the productivity, innovation and earnings gaps between Northern Ireland and the UK average.

Maintaining the status quo in economic strategy is unlikely to significantly improve Northern Ireland’s economic performance, relative to the rest of the UK.

So, it is reasonable to suppose that a continuation of previous performance is unlikely to substantially narrow or close the existing gaps between Northern Ireland and the UK average in terms of performance.

The current macroeconomic climate and the absence of public spending growth is likely to further disadvantage the region for the foreseeable future.

Given that an improvement in economic performance towards a defined vision is desirable and can be assumed to be feasible it is worth considering how policy might be adjusted to promote such an outcome. This is particularly appropriate in the current climate of austerity where pressures on public expenditure are likely to be continued well into the next Spending Review period beginning in 2015.

Northern Ireland is the only devolved region that has not been subject to a comprehensive review of fiscal policy and legislation/proposals to devolve a variety of fiscal powers.

Recent developments in terms of comprehensive reviews of the fiscal powers available to the devolved administrations in both Scotland (the Scotland Act 2012), potentially in Wales (the Silk Commission) and in the English regions (the Heseltine Growth Review), suggest there is a real opportunity to begin a similar debate in Northern Ireland as to the further devolution of fiscal powers that could assist in rebalancing the economy.

Northern Ireland’s current position in terms of funding the devolved administration could be characterised as one of:

• Very limited fiscal variation, where only a few taxes, the Regional Rate and Air Passenger Duty (APD) direct long haul, are under devolved control and where there are limited powers to borrow and gain extra resources from, for example, the EU;
• Overwhelming dependency on the block grant from HM Treasury;
• Being the recipient of a longstanding and sizeable net transfer from the UK Exchequer.

In considering which taxes might be devolved it is important to quantify the revenue generating potential of those taxes.

Drawing upon the deliberations of the Calman, Holtham and Silk Commissions in determining which taxes might be devolved, it is helpful to define taxes as “major” and “minor” in terms of the size of the revenues raised. Devolving a major tax will potentially make a greater contribution to increasing the revenue stream, autonomy and accountability of a devolved assembly. Having said that, it might still be decided to devolve certain minor taxes because of their potential contribution to particular economic, social or environmental policy agendas.

In terms of the scale of revenues collected three taxes stand out as major: Income Tax, National Insurance Contributions and VAT. In practice, only Income Tax is a strong candidate for devolution, as has been identified in both Scotland and Wales. Devolving and thus potentially varying the rate of National Insurance Contributions from that of the rest of the UK would in practical terms be hard to reconcile with welfare and benefits policy commitments. EU law appears to prohibit regional variations in VAT rates.

Corporation Tax is not a major tax, although the revenue raised is greater than some of the minor taxes. There has been a prolonged debate about, and campaign for, devolving Corporation Tax varying powers to Northern Ireland. The Prime Minister has indicated that any decision about this will not happen until after the Scottish independence referendum in September 2014. In addition, devolving Corporation Tax is subject to the strict Azores Judgement and would have a direct and substantially detrimental impact on the block grant for many years.

In identifying potential taxes for fiscal devolution in Northern Ireland, we should make allowance for:

• Developments in Scotland (additional Income Tax variation powers, Stamp Duty and Land Tax, and Landfill Tax) and proposals in Wales (Silk proposed Income Tax variation, Stamp Duty and Land Tax, Landfill Tax, Aggregates Levy and APD);
• Developments in England under the Heseltine Growth Review proposals where, while the majority of the proposals to decentralise powers to the English regions/cities seem to have been accepted, the magnitude of financial transfers have yet to be determined;
• In addition, a number of criteria will influence the suitability of a tax for devolution:

Is devolution possible without a major negative effect on the tax base in the rest of the UK?

• Further reform of the tax base across the UK, whereby fiscal incentives will add to the attractiveness of Northern Ireland for foreign direct investment (FDI) and indigenous investment, even without specific regional devolution. The recent progressive reduction of Corporation Tax rates, introduction of the Patent Box regime and increased tax incentives for R&D are examples where UK wide policy has had a potential benefit to Northern Ireland. Regardless of what happens in terms of enhanced powers it is important to make the most of the incentives Northern Ireland already has.[1]

Given these considerations and the experience of Scotland and Wales, the following taxes would theoretically become candidates for full or partial devolution in NI:

• Income Tax
• Stamp Duties
• APD
• Landfill Tax.

Of the so-called “major taxes”, only Income Tax is a major tax in terms of revenues raised.

The size of the revenues raised and the fact that devolution has already occurred in Scotland and is proposed for Wales is an argument in favour of considering Income Tax devolution for Northern Ireland. At the same time, there are some other significant considerations relevant to whether Income Tax should in fact be devolved. There is considerable uncertainty about the extent of responsiveness on the part of employees to tax rates and the elasticity of labour supply. This is both in general terms and among Basic and Higher Rate[2] taxpayers, but there are indications from the external evidence that if the Assembly wished to maximise revenue it would increase the Basic Rate by a small amount and hold the Higher Rate at current levels.[3]

Care must be taken in choosing the method to index deductions from the Northern Ireland spending block if any of the taxes were to be devolved.

This would especially be the case in terms of Income Tax as a large source of revenue (such deductions are a requirement under EU law). Indexing to the growth of UK revenues for that tax (the method favoured by Holtham for Wales) has the advantage of insulating the block deduction from the general UK economic cycle and UK policy risk (things that would have a general impact on the amount of Income Tax revenue collected but are not under the control of the devolved administration). However, it is much less clear, based on the past performance of the Northern Ireland economy, that Northern Ireland would be able to grow its regional Income Tax base above the UK average.

So, it is uncertain whether the gains to revenues could outgrow the deduction from the spending block. This creates the risk that Income Tax devolution would lead to the Assembly having less resources in the future. Such a risk has to be weighed against any benefits (e.g. economic or political accountability) from such devolution.

If Income Tax was devolved policy makers must balance the respective priorities of revenue maximisation, the promotion of entrepreneurship amongst high earners and distributional objectives.

Trade-offs are likely and it is very unlikely the Assembly could use Income Tax variation to pursue all three of these goals at once. This reinforces the point that the question of whether the power to vary a tax should be devolved (the subject of this report) is in principle separate from the question of how such a power might be used. Greater tax powers might require the Assembly to clarify or define its policy position, e.g. on the relative priority to be given to economic efficiency or distributional considerations.

Defence of the Northern Ireland funding block is understandable but not the only consideration.

Especially during a period of austerity, it would be entirely understandable if the Executive gave strong emphasis to defending the extent of the block grant to Northern Ireland (hence producing a concern about possible off-setting reductions in the block grant which arise from fiscal devolution given the need to ensure compatibility with the Azores Judgement).

This reinforces the point that devolution of a tax may require confidence that it could produce sufficient compensating growth in the private sector to set against any reduction in the block grant. This confidence will be reinforced if the induced gains in other tax receipts relate to tax streams which are also under devolved control. Even if the other tax streams are not devolved such a policy might be justified if the aim were to contribute to rebalancing the Northern Ireland economy, i.e. the % share of the private sector and social enterprise sector compared to the public sector.

Fiscal variation should be seen as a supplement to other policy emphases and not as a solution in its own right.

Northern Ireland has hitherto not engaged in the level of debate about wider fiscal powers which has been going on in Scotland and Wales. While it may be useful to initiate that debate, it does not mean that enhanced fiscal powers would, in themselves, become a game changer to transform the economy.

Other, previously identified objectives should still be pursued; these would include improving the quality of management across the private, public and third sectors whilst having a single minded emphasis on raising productivity and exporting performance through gains to R&D and management capabilities. Indeed, regardless of what happens in terms of enhanced fiscal powers, the scope to use the UK’s existing business tax package (e.g. Corporation Tax falling to 20% in 2015, and Patent Box now in place) should be maximised as a selling point for Northern Ireland as a destination for international investment.

[1] Of course, none of these characteristics of the UK business tax system mark Northern Ireland out relative to other UK regions. Our point, however, is that we suspect more could be done to sell these attractions to potential international investors given that it is undoubtedly the case that the UK overall has a relatively attractive offering compared to many other Western economies.

[2] Strictly speaking, “Rates” as both the 40p and 45p rates are relevant.

[3] It remains unclear how far an elasticity taken from US or UK experience would accurately predict how the Northern Ireland labour market would respond to, say, a 2p increase in the Basic Rate or a 3p decrease in the Higher Rate. The revenue maximising argument for actually cutting the Higher Rate becomes stronger if we assume a very strong behavioural response (i.e. considerable increase in labour supply) and/or strong in-migration by high earners from, say, GB and the Republic of Ireland.

This report is part of a series of research on the Northern Ireland economy. You can see the rest of our reports here.

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NICVA's Centre for Economic Empowerment (CEE) is an economic think tank and skills development programme.